Printing lots of cash

In an article I wrote here in December last year I included a chart showing the amazing spike in the amount of US cash entering into the global economic system. It was stunning because of the unprecedented magnitude of the spike. The Americans have been printing cash like there is no tomorrow. I suspect that some people didn’t really grasp what the chart was saying because it was a little bit technical but also because the shadows on the background of the chart kind of obscured the spike at the end of the chart unless you were paying close attention. If you want to go back and have another look then click here.

Or if you want to see essentially the same chart with slightly less detail but delivered with more entertainment value and drama then tack a look at the Glenn Beck video below.

If you have a large deflationary collapse in the banking sector then you ought to have a large increase in the supply of base currency. The inference in Glenns entertaining video is that such a spike would not have occurred on a gold standard. Setting aside the fact that I think we would have avoided this crisis if the USA had been on a gold standard and interest rates had been freely set by the credit markets I don’t otherwise think Glenn is entirely correct. A deflationary banking collapse will always create a massive demand for cash. This would drive up the real value of cash relative to most other real world things including gold. In order to maintain a fixed price of gold (which is after all what a gold standard entails) you would need an injection of new cash. Or looking at it the other way around, to prevent the value of cash rising relative to gold due to demand you would need to dampen any potential rise in the value of cash by supplying more of it.

Of course what should happen next as the crisis passes and the demand for cash declines back to normal is that you should see a massive winding back of the base money supply. A gold standard would essentially do this automatically. If the central bank does not replicate this winding back then you are left with a lot of cash in the system for which there is no longer the previous high demand. At this point the risk of inflation becomes extremely real and essentially inevitable.

Hopefully the central bankers in the USA are wise enough to know this stuff and they will move to avoid such problems. I must say however that faith in the wisdom of central bankers isn’t something I have a lot of and Glenn Becks worst fears may yet come true.

18 thoughts on “Printing lots of cash”

I love watching economists and journos explaining why something they did not predict was inevitable and bound to cause huge problem and then offer solutions that would have averted the crisis if only they had been enacted prior to the crisis actually occuring.

Secondly, my grasp of economics is shaky at the best of times but this GFC solution seems like a doozy to me. If I understand correctly this crisis has been caused by people trying to maintain a higher standard of living than they can afford and therefore caused a huge debt bubble which later burst bringing the global financial system to it’s knees. This bit I understand. The solution on offer by governments around the world seems to be “get people to spend more even if we have to go into more debt to do it”. Is this just some multinational sense of irony at play or do they really expect this to work?

Which brings us to the gold standard… you can not un-ring a bell, not that I think the gold standard is a bad idea, but that horse has bolted.

Surely the solution is to cut up the credit cards and live within our means.

If by un-ringing a bell you mean we can’t return to a gold standard then I would suggest you take a closer look at history. Nations have returned to a gold standard many, many, many times in the past. Sometimes after a short flirt with floating currencies, sometimes after very long periods. If we went back to a gold standard it wouldn’t be an overly original sort of thing.

If you have a fully convertible gold standard the government would be unable to supply cash to the system as it would break the gold standard.

This is why i keep saying to you that you would need to remove every single rigidity out of the system before you went to gold as it would otherwise break apart. This is why Argentina had to break it 1:1 fix with the US dollar. It supplied to many peso’s in the system and the domestic economy was unable to make the necessary adjustment in terms of the general price level.

We can’t ever go back to gold unless labor and goods markets are able to make up and down price adjustments.

What Beck is talking about is serious indeed for the potential of future inflation. I really don’t get it though as the TIPs markets are not showing any expectations for high inflation levels further out, otherwise the premium to the regular bond markets would be higher for similar duration. They’re not. Gold is also looking like a shitty investment as it’s made it’s move and looks increasingly like its unable to crack $1,000.

So while people like Beck are worried about high levels of inflation down the road the financial markets are really reflecting this.

Perhaps the level of debt inflation is so high and so pervasive that it actually is overshadowing the increase in the money supply that the fed has supplied to the market. Don’t know.

I starting to put on bets , carefully though that inflation is will be coming back by the end of 2010 onward.

My thesis is that the Fed will find itself in the same predicament it found itself in the early 90’s when it lowered interest rates to very low levels and then it couldn’t sweep all the money out of the system without creating another crash and so we go into another credit creation cycle again.

I’m buying beaten down US banks such as Bank of America betting that the yirld curve will remain positive for much longer than people think and that the fed will be unable to sweep the money out and bank stock go vertical. It’s not a bet for the faint hearted though. This could be a 15-20:1 pay back.

It’s important to watch what the TIPs market do over the course of time as bond markets really do have a PhD in economics.

Here’s a hedge fund guy I really respect and alsways listen to for what I’m saying. I do hasten to add though that the dude is in the UK which is really the most screwed up large western economy going at the present time, so his views may be a little skewed.

Hugh Hendry… the should have sub-titles for his Scottish accent is hard to take.

I disagree with Hendry about using Japan as an example. Japan wasn’t really that aggressive in quantitative easing.

JC – you seem to have missed my point. Rather than being unable to supply cash to the economy due to a gold standard the retension of a gold standard would necessitate a fresh supply of cash during a debt deflation. Otherwise the value of cash would move upward relative to gold which would violate the standard.

I’m aware that a number of things would need to be done in order to make a gold standard workable. Just as a number of things would need to be done to make less welfare and lower taxes workable. That should not be reason to give up.

Argentina had to make some tough choices but ending convertibility was neither the only choise nor the best choise. However they were not helped by a deflating US dollar which also effected the asian fixers.

Rather than being unable to supply cash to the economy due to a gold standard the retension of a gold standard would necessitate a fresh supply of cash during a debt deflation. Otherwise the value of cash would move upward relative to gold which would violate the standard.

Sp you wouldn’t have a gold standard then, right.

I mean the idea of a gold standard is that the currency is basically and expression of the weight of gold. Supplying additions to the money supply would simply negate that.

Yes, Argentina made the choice it always makes which is to cheat lenders of their money.

Terje; I seem yo be catching a whiff of the Social/Douglas Credit theories in this argument. Is this just that Douglas had some validity in some areas of his theory?

Actually, checking him out on Wiki, I tend to find a lot of differences between the article and the perceptions supporters seemed to have back in the early 70s here. Back then it was mostly pushed by the far right, who wanted massive money creation by government which would then be spent on ‘national projects’ and withdrawn as it came back.

I was always inclined to think that even if it worked, it would distort the economy in the direction of reliance on massive government expenditure.

Douglas had some interesting social ideas though:

“Systems were made for men, and not men for systems, and the interest of man which is self-development, is above all systems, whether theological, political or economic.” and:

“The individual voter must be made individually responsible, not collectively taxable, for his vote.”

I mean the idea of a gold standard is that the currency is basically and expression of the weight of gold. Supplying additions to the money supply would simply negate that.

JC – The idea of a gold standard is to keep the value of the currency (eg cash) fixed with respect to gold. If you have a sudden demand shock, where demand for cash goes through the roof, then the only way to keep the value of the currency from increasing with respect to gold is to negate the effect of the sudden increase in demand with a sudden increase in supply.

The way I am reading you it seems that you have it in your head that you can fix the value of the currency by fixing the supply. In an open economy nothing could be further from the truth. If the USA today fixed the dollar to gold they would need to constantly adjust the base money supply to ensure that the exchange rate with gold was at target. I’m sure you know this but your comments seem to suggest otherwise.

Jim – I’m not familiar with Social/Douglas credit theory so I can’t really comment on it. I’m not particularily trying to make an argument for or against anything, I’m mostly just stating how things would work under a gold standard.

No terje, yoiu don;t the the relationship of a gold standard to fit with what ever is happening in the economy as that would basically negate the need for a gold stanadrd and you may as well keep fiat current.

In a proper gold standard the relationship of the currency is fixed to gold in other words – in our case – the Australian dollar would be a simply a fixed weight to gold. Add more into the system and that would change.

If the USA today fixed the dollar to gold they would need to constantly adjust the base money supply to ensure that the exchange rate with gold was at target.

Okay, you you’re using a gold targeting system. That would simply break down like the gold exchange standard that was used under Bretton woods.

A gold standard is any standard that keeps the value of the currency fixed in terms of gold. A gold exchange standard is a gold standard even if the currency is a fiat currency. It may not be the only form of gold standard or even the best but it is a gold standard.

The gold exchange standard under Bretton Woods lasted a long time. As did the former gold exchange standards. By comparison the monetary regime post Bretton Woods has changed in quite substantial ways several times.

Yes gold exchange standards break down. All systems do when people in positons of power don’t like the consequences of the system and are willing to remove the system. At the margin a system that imposes discipline may almost always be dismantled or discontinued by those in power that don’t like discipline. That does not mean the system is bad or that we should not return to discipline. The evidence of the last 100 years is that liberal democracies generally become social democracies, yet I’m sure you would agree we should return to liberal democracy. If I said to you that capitalism was a bad system because most capitalist societies become socialists societies you would rightly mock my criticism of capitalism. Likewise I can’t see much point to your observation that gold exchange standards break down. It seems to me like a largely pointless remark. Like saying that you don’t like Labor governments because they always lead to Liberal governments.

Gold exchange standards didn’t break down because they have awful economic consequences. They break down because they have awful political consequences for governments that tax and spend unwisely. The US economy would have been better off if Nixon had not ended the gold exchange standard and had instead honoured US debts. However Nixon thought that he could have a free lunch by ending the gold standard. So he ended it.

Of course, the trouble with a gold standard is that the Central Authorities try to standardise the units of exchange. A Gold money system would be different, meaning direct use of gold in coins. A libertarian should support the free use of any metals as money, of course. As we don’t yet live in Lockesland, we will put up with paper currency as a second or third -best option.
(John Locke was the first author to write down positive ideas about the right to own and use private property, so I would name any future land which had strong laws about protecting private property, ‘Lockesland’. My preferred name for a capital would be ‘Lockeston’.)

The GFC was caused by well intentioned but ultimately bad policies and regulations in the face of the fiscal pressures of the Iraq War and a central bank with a focus of maintaining growth rather than sound money.

* Banks were forced to lend to those who couldn’t afford it (CRA, HUD and mnay other parellel legislation and regulation). The idea that this is a debunked myth has been robustly debunked itself.

*Ratings agencies were a protected species working in a sheltered industry, the regulatory barriers to entry were very high (where any decent auditing, economic consultancy or financial maths outfit could compete). (This helps explains crazy ratings and CDS spreads).

*The US Government gave a 2 trillion with a T guarantee to Government sponsored private mortgage originators (Freddie, Fannie) who had a charter to lend to those who couldn’t afford it and to buy off debts banks didn’t want on loans they were forced to make.

*The Iraq war increased the oil price, took away investment in the US and increased the real cost of borrowing. Eventually this would impact on the unemployment rate.

* The US FRB had real interest rates as low as -2% in 2004. This totally distorted credit and propterty markets. When the vulnerabilities above were exposed in this bizzare market by the forced directly above, there was a short, sharp recession in early 2007.

The unemployed cannot afford a loan at all. This is when payments began to collapse and this precipitated the next series of economic downturns and insolvency crises.

Your solution of cutting up the cards may be right but would have been impossible in America where Government forced debt down the world’s throat.

Mark,
I wasn’t picking on “the multinationals”, I chose my words incorrectly, perhaps I should have said “world-wide” or “international”.

I happen to agree with what you have said. The point I was trying make was that governments, in particular central treasuries, are the last people that should be allowed to form financial policy and especially should not be allowed to regulate financial institutions. Lets face it, they couldn’t run a chook raffle and balance the books. Any bank worth it’s salt would not lend money to someone who could not afford to repay it unless they were forced into it. No amount of realistic capital growth over of few years is going to make it worthwhile to lend someone 110% of the market value today if they cannot meet the repayments. Sure there is going to be a certain amount of bad debt, these things happen, but they are a risk that is managable. When very iffy loans are repackaged as AAA you are asking for trouble. In short let people whose job it is to lend money and manage risk do their job. Most of them would be pretty good at it if they didn’t have one hand tied behind their back.

An interesting aside- I am reading a book called ‘Currency Wars.’ All about counterfeiting and stuff like that. We imagine that nations only go in for counterfeiting when they are fighting each other. Well, not all wars are hot wars. Some are culture wars. I shouldn’t have been surprised that Iran and North Korea are both printing fake American bills.
I am surprised that about 10% of American dollar bills outside of America are clever forgeries, almost indistinguishable from the stuff printed in America. You haven’t heard about it because no sane person wants to add to the turmoil in the markets, but it’s real.

Darn! What gave me away? I promise to get back on the medication real soon!
Don’t worry, TerjeP! Libertarians are the only sane people on the planet! Right, fellow libertarians? We can be entrusted to use the knowledge wisely.
And nobody else reads these insights, so the world economy is safe.

Follow Blog via Email

Today in The Australian How often in recent years have we thought, as Hannah Arendt did on learning of the death camps, “many things are possible, but this ought not to have happened”? Now, after another week of terrorism, and … Continue reading →

Australia is by a long chalk the least racist country on the planet. People from everywhere just live here and rub on together. Maybe some tall-poppy syndrome problems, but basically our ethos is “have a go”. No one’s ethnic or … Continue reading →

Modern Monetary Theory, or MMT, is all the rage in the halls of Congress lately. To hear the Progressive left tell it, MMT is not unlike a goose that keeps laying golden eggs. All we have to do is pick … Continue reading →